Penelope Lemov is a GOVERNING correspondent. She was GOVERNING's health columnist and was senior editor for several award-winning features.

The muni bond market is not the friendliest place to be these days. The economic cataclysms that brought on the Great Recession took its toll on municipal bond insurance agencies, which have all but disappeared. Powerful, highly rated states might not need insurance to reassure investors about their credit-worthiness, but smaller issuers like cities, counties and school districts, are having a harder time letting investors know they aren't a risk.

In an effort to do something about the problem, the National League of Cities (NLC) announced it is considering starting its own mutual bond insurance company with the private mortgage insurer, the Radian Group. I recently spoke with Don Borut, executive director of NLC, about the project and when he thinks relief for local issuers might be in sight. Below are highlights from our conversation.

How did this idea get started?

RELATED

Three years ago we put together a Blue Ribbon Commission of folks from local government and the private sector to see what challenges there were in terms of bond insurance. At that time, the bond insurance companies that were operating had been downgraded, [making it hard] for municipalities to get bond insurance. I asked a naïve question: Since there's an incredibly low number of defaults in the muni market, why do you need insurance? Part of the answer is that there are so many issues out there that the retail buyer of muni bonds wants assurance of the credibility of those bonds. Bond insurance does the due diligence on an issue -- gives the borrower confidence in the issue.

It was not our intent initially to create a company. But what we did realize was that one possible way to provide bond insurance was by using a totally different format -- a mutual insurance company whereby the issuers themselves own the company. They would do that by not only paying for the insurance but by investing in the company through surplus notes.

How do you get a mutual insurance company started?

First, you have to have upfront money to cover losses. The model we developed was to have private funds put up that money. They would get a return that would be desirable. Besides, the potential risk for muni bonds is very low. We talked with a large number of companies about this and found a lot of interest. Ultimately, we decided to work with Radian. The bond insurance infrastructure they had, their willingness to put capital in and develop capital was attractive to us. We signed a memo of understanding, and are putting together a business plan, raising private capital and insuring that we have licenses. For this to take off, we need to get a high rating from [Standard and Poor's] and Moody's [the credit rating agencies].

Why would issuers invest in this?

They would get a return in terms of lower rates on the bonds they issue and a return on their investment. Based on the work we've done to date, we believe, Radian believes and others believe that this could provide bond insurance at an attractive rate. This is important. Municipalities need to borrow for infrastructure.

What kind of bonds would be covered? Would states be eligible?

We're looking now at GO [general obligation] bonds for municipalities -- bonds backed by the full faith and credit of the city behind the issue. We are going to do aggressive due diligence to make sure the risk being taken on is prudent. Right now the focus is on municipalities, not on states. We won't even speculate on that.

The credit rating agencies have put out new criteria for rating bond insurance companies. How does that affect your plan?

It's to our advantage. We are confident that with the model we've developed we can demonstrate and meet the criteria. We are not investing in other things. The way we've structured the plan, we not only will have adequate capital but we will have in place the management capacity to operate it. With the mutual [bond insurance company], the issuers themselves will be overseeing the kinds of bonds being insured.

What does NLC bring to the table? Would you be an investor in the new company?

Our role is in putting this concept together. We're not putting up any money, but we are putting up the reputation of NLC and that is, in effect, the equity we're putting into it. We know from talking with private-sector folks that by being involved in the development and design, NLC adds significant value. Could Radian do it on their own? If they did, they would not have a mutual company that makes this more attractive in terms of cost to issuers. We add value by our reputation, which gives them recognition in the marketplace.

How close are you to completing the deal? When can localities expect to see a new insurance company?

We're in the due diligence and development stage. We haven't started a company. There is a point where a decision will be made whether or not to proceed. You don't do something like this on faith but on analysis. At the end of the process, we've got to have every reason to believe we will be able to get a high rating from a rating agency. The rating agency has to have confidence that the model we're proposing is different but one that is economically viable.

It is exciting. We talk about public-private partnerships. This truly is one. We are getting commitments of capital, developing the infrastructure and getting licenses. However long that takes, it will take. Then we will take it to our board for a final decision. Radian will do the same.